UPDATE 2-Brazil's Rousseff vetoes parts of oil royalties bill

* Producer states to keep royalties from existing contracts

* Royalties from future concessions to be redistributed

* All future royalties must be invested in education

By Anthony Boadle

BRASILIA, Nov 30 President Dilma Rousseff on
Friday vetoed parts of a controversial royalties bill that pit
Brazil's oil-producing states against the rest of the country in
a battle over future oil wealth.

Seeking a compromise on perhaps the most divisive issues to
arise during her nearly two-year-old presidency, Rousseff vetoed
clauses that would slash income for Brazil's main oil states,
including Rio de Janeiro.

Her veto changes the bill so that producer states continue
to receive royalties on output from existing oil concessions.
She signed most of the rest of the bill as passed earlier this
month by Congress, redistributing royalties from all future oil
concessions so that non-producing states get a greater share.

The legislation, approved with the overwhelming support of
states with no oil production, is an effort to spread oil
revenues more evenly nationwide as massive new offshore oil
discoveries near Rio de Janeiro and other southeastern states
begin producing in the coming years. The new discoveries, if
developed successfully, could catapult Brazil into the ranks of
the world's top petroleum producers.

Rousseff's changes also mandate that all royalties from
future production contracts be used to fund educational
programs. The shift, which wrests funds away from local
politicians and their pet projects in producer states, is
important for a left-leaning Rousseff administration focused on
continued efforts to eradicate poverty across Latin America's
biggest country.

The new law is also crucial for Brazil's oil industry, which
has been hobbled in recent years by regulatory uncertainty
surrounding the new discoveries.

Auctions for new oil concessions, for instance, have been on
hold until a new royalty framework is decided. The concessions
are necessary for Brazil to develop new discoveries as quickly
as possible, especially at a time when state-run oil company
Petrobras, a mandatory partner in the big new fields,
is struggling to meet existing production targets.

But a provision in the original bill to change royalties on
existing concessions met stiff opposition in Rio, responsible
for three-quarters of Brazil's current oil production, and the
other producer states of Espirito Santo and Sao Paulo. On
Monday, thousands of demonstrators joined a Rio protest staged
by the state government to urge Rousseff to veto the bill.

The revised law, then, marks a victory for producer states.

Renato Casagrande, the governor of Espirito Santo, late
Friday said Rousseff with her veto "acted coherently and
courageously," preserving "judicial security" in Brazil.

"Rio thanks President Dilma," Rio's Governor Sergio Cabral
said in a statement.

Rio was especially concerned it would lose crucial revenue
as it invests tens of billions of dollars to host the World Cup
of soccer in 2014 and the Summer Olympics two years later. The
state would have forgone $39 billion in revenue by 2020 under
the original bill, Cabral said, warning that Rio "would have to
close its doors."

"There would be no Olympics, no World Cup, no payments for
retirees and pensioners," he added at the time.

LEGAL CHALLENGES

Rousseff herself opposed the original bill, in part because
the oil producing states had threatened to go to the country's
Supreme Court to contest any altering of existing contracts.

A drawn out legal battle would have created legal risks for
the oil industry and hindered plans to hold new auctions next
year. That, in turn, would further delay the oil bonanza
expected from the big new "sub-salt" reserves, known as such
because they lie beneath layers of salt deep under the Atlantic
seabed.

The royalties bill was passed a year ago by the Senate but
held up in the lower house of Congress by opposition from
Rousseff and the oil producing states. The legislation had been
in the works since 2007, when Brazil discovered the sub-salt
reserves.

The reserves, in a New York state-sized area off the coast
of Rio and Sao Paulo, may contain as much as 100 billion barrels
of oil and natural gas equivalent, according to the Brazilian
Petroleum Institute at Rio de Janeiro's state university. That
is enough to supply all U.S. oil needs for more than 14 years.

NEW DISTRIBUTIONS

Along with her veto, Rousseff revised the percentages that
the federal, state and municipal governments are to receive from
future production.

Under those changes, producer states will receive 20 percent
of the royalties collected from new fields, down from a current
26.5 percent. The municipal governments of productive areas will
receive 15 percent, while the federal government's share of
royalties from future concessions will fall from 30 percent to
20 percent next year.

Non-producing states will see their share of royalties from
future oil contracts increase gradually from 1.75 percent at
present to 27 percent by 2019.

The government did not disclose how it would administer the
new rules that require royalty income to be spent on education.
The requirement, however, is an effort to ensure that Brazil
uses the windfalls to better a workforce that has long been
short on skilled labor.

It is also an effort to avoid the so-called "oil curse" that
historically has plagued many big petroleum producers, who have
relied on oil income without developing the rest of their
economies. The royalties must be used to "prepare Brazil to be a
post-petroleum Brazil," said Aloizio Mercadante, the country's
oil minister, at a press conference.

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